A Price for Raising the Debt Ceiling
January 14, 2011
Addressing the possibility of the GOP-led Congress not voting to raise the debt ceiling, Austan Goolsbee, President Obama's top economic adviser, histrionically asserted this month: "This is not a game. If we hit the debt ceiling, that's...essentially defaulting on our obligations. The impact on the economy would be catastrophic."
In context, his comments are more than a bit hypocritical. Over the past four years -- including the last two years of the Bush presidency -- he and his boss supported every big, misguided spending program they could find, regardless of how much the electorate protested, says Arthur Laffer.
In March, the debt ceiling of $14.3 trillion is going to be hit. Today's debt number is about $13.9 trillion and rising faster than a jack rabbit. Mr. Goolsbee is correct that it would be a mistake to use the debt ceiling as the means to control Mr. Obama's spendthrift ways.
But just because the debt ceiling should be raised on this occasion does not mean that the logic behind Mr. Goolsbee's argument -- that not doing so would be "catastrophic" for the economy -- is accurate. On the contrary, cutting spending and cutting it drastically would not hurt the economy. It would, in fact, help the economy, even if done now, says Laffer.
- The mistake Mr. Goolsbee makes when he says that a massive reduction in government spending will reduce output is to confuse accounting with economics.
- In the simplest accounting terms, gross domestic product (GDP) is equal to consumption plus investment plus government spending -- that's true.
- But reducing government spending doesn't reduce GDP dollar-for-dollar, as this accounting equation would seem to be saying.
- Reducing government spending is not only a reduction in one of the components of GDP, but it is also a reduction in effective taxation and a reduction in payments for non-work and less output.
- In due course, cutting government spending will increase private output (in this case consumption plus investment) by more than the reduction in government spending.
Source: Arthur B. Laffer, "A Price for Raising the Debt Ceiling," Wall Street Journal, January 13, 2011.
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